Memo to American Conservatives: America Is NOT Greece

Memo to American Conservatives: America Is NOT Greece

February 23, 2012

European leaders next week will sign off on another $172 billion bailout for Greece, one small step back from a disastrous debt default. When the deal is signed, brace yourself for a chorus of charges from President Obamas critics that his policies will make America the next Greece. These Chicken Littles are talking nonsense. They misunderstand Greeces real weaknesses and our genuine strengths, along with governments role in each. Moreover, they miss the issue in the Eurozone crisis that matters most to America the new bailout will not prevent a broader European financial crisis that could tip the United States back into recession.

By the critics primitive reasoning, Greece has large deficits and public debt, and so does America, so the two countries must be headed for the same fate. If that were true, most of the world would be headed for default, since most nations today have large deficits and public debts. The economic fact is, the grave problems facing not only Greece, but also Italy, Portugal, Spain and Ireland lie much more in their economies than in their national budgets.

Yes, Greeces deficits skyrocketed when the 20082009 financial crisis stalled out its economy as in most of the worlds countries. And yes, the public debt of Greece, and Italy too, was large already as a share of GDP, so the burden of financing the new debt came on top of the burden of regularly refinancing their existing debts. But even that doesnt explain much, since Spain and Irelands existing national debts were modest by world standards. At the same time, Japans public debt is larger than almost anyones as a share of GDP, and no one worries about a Japanese default.

The economic issue in sovereign debt defaults is not the size of a nations public debt, but its economys capacity to finance it. The problem that Greece faces followed closely by Italy, Portugal, and Spain is that its economy is relatively unproductive and uncompetitive. When its financing burden soared in the deep recession following the 2008 meltdown, its businesses and people found themselves financially strapped, and so unable to generate the additional savings to finance the new debt. And Greece cannot become more competitive and boost exports by depreciating its currency, because it no longer has a national currency to devalue. Along with Italy, Spain and the other countries facing debt peril, Greece uses the Euro and the Euro exchange rate is set by the larger, more productive economies of Germany and France. Nor can Greece spur new investment in its economy with easy monetary policies, since the European Central Bank controls that for Eurozone members.

So, it is not simply Greeces large deficits and government debt that raise the possibility of default. Rather, that prospect rests on what can be called a perfect storm in public and private finance. Yes, Greece has fast-rising public debt. But one of the key reasons is that the Greek economy hasnt been strong and productive enough to come out of a deep recession now four years old and running. Thats the main reason why Greeces national debt soared from 113 percent of GDP to 163 percent in the last three years, despite its recent austerity. Its also why Greek businesses and households cannot generate the additional savings to finance that new debt.

Greeces low productivity, on top of its continuing recession, also has discouraged foreign investors from buying its bonds. Once the risk of default took hold in the minds of those investors, they have demanded much higher interest payments on new Greek government bonds to offset that risk. Those higher interest rates only compound Greeces problems, since they greatly increase the burden of both financing the new deficits and refinancing the governments prior debts. To top off all of this, Germany has turned these grim conditions into an imminent crisis by insisting that Greece embrace harsh austerity, right now, to reduce its deficits. But as the International Monetary Fund has warned, additional austerity in an economy already in recession or just recovering from one will only expand deficits.

Whatever President Obamas economically-untutored critics may claim, Americas circumstances are different from Greeces in every respect. The U.S. recession ended in mid2009 thanks to stimulus from the Presidents program and the Fed. Savings by both American businesses (retained earnings) and households shot up, providing additional resources to help finance our rising deficits. Moreover, the U.S. economy is the most productive in the world, attracting hundreds of billions of dollars in foreign funds to help finance both our business investments as well as our deficits. And the lowest long-term interest rates in generations signal clearly that global investors are confident America will stabilize its national debt as a share of its GDP. The only time that the United States has ever flirted with default came not from the economy or deficits, but from the reckless behavior of conservative extremists last year who threatened to block the debt ceiling legislation. And for the record, the U.S. public national debt as a share of GDP is considerably less than half that of Greece.

Credible signs are now appearing that the U.S. expansion is finally accelerating. The greatest threat to that upturn is a Greek debt default which then spreads to Italy or Spain. Unfortunately, that threat is very real. The conundrum here is that the new Eurozone bailout of Greece is predicated on the Athens government implementing yet more austerity and thats a losing strategy. Additional austerity almost certainly will only increase Greeces deficit and debt, not tame them, requiring more bailouts in the future.

At the same time, much of the Greek public unequivocally opposes more austerity. Its hard to blame them. Greeces GDP has contracted 25 percent through the last four years of savage recession, and unemployment there is now over 20 percent. Moreover, wages have fallen at least 20 percent the Eurozones only answer to Greeces low productivity and non-competitiveness. Now, Germanys Angela Merkel is insisting they accept another large dose of austerity. They just might say no, at which point a genuine default probably cannot be avoided.

That leaves Merkel with a clear choice. She can finally accept that the European Central Bank must stand behind the sovereign credit of every Eurozone member, or pray that a Greek default wont spread to Italy or Spain and threaten the solvency of most large European banks. Our own banks would probably survive a new European banking crisis, but theres little doubt that this scenario would cost the U.S. economy. So, while America has little in common with Greece fiscally or economically, our own short-term fate may still rest in its hands.

The Economics and Politics of Inequality, Part 2 The Role of Tax Policy

February 16, 2012

Economic inequality is an important issue this year, because a growing number of Americans now see it as a threat to their living standards and aspirations. Mitt Romney and others say that envy, not facts, drives this debate. But the facts are too large and well-known to dismiss, starting with the astounding one that from 1976 to 2007, the share of the countrys annual national income which the top 1 percent takes home rose from 8.7 percent to 23.5 percent. Stated differently, over the last three decades, almost 15 percent of annual national income shifted from the bottom 99 percent to the top 1 percent. To be sure, most Americans found this upward redistribution acceptable as long as their own incomes were rising. But that changed in the 20002007 expansion when, for the first time on record, the incomes of most Americans stagnated or fell through ostensibly good times. And since the average income of the top 1 percent increased 65 percent over those same years, inequality accelerated.

Does this new inequality reflect simply the way that an advanced market economy operates these days, or has public policy contributed to it? The truth is, we are not helpless in the face of economic forces, and tax policy in particular is a real factor.

To understand how and why, we have to start with the distribution of wealth as well as incomes. The reason is that most of the income of those at the top comes from their wealth, in the form of capital gains, interest and dividends. And wealth in America is now distributed even more unequally than incomes. In 2007, the top 1 percent owned nearly 35 percent of all wealth in the United States, and the top 20 percent held 85 percent. Moreover, this inequality of wealth is even more pronounced for the financial assets that produce the capital gains, interest and dividends. In 2007, the top 1 percent held almost 43 percent of the value of all stocks, bonds and other financial instruments, including pension plans and retirement accounts; and the top 20 percent held an astonishing 93 percent of all those financial assets.

Tax policy is a link between the inequalities of wealth and income, because we tax the income from wealth at lower rates than the income that most Americans earn from their own labor. That is why, of course, Warren Buffett pays a lower tax rate than his secretary and how Mitt Romney managed to pay only 13 percent in taxes on an income of more than $20 million last year. Moreover, this tax favoritism for the income earned by those at the top has a compounding effect on the growing inequalities of both income and wealth. The smaller tax bite leaves more of the income of those at the top to be reinvested in more financial assets, which then generate more income than is taxed at lower rates, and on and on.

The defenders of these arrangements say that everybody benefits, because low taxes on capital income encourage more investment that raises productivity, which in turn lifts everyones wages. Its a nice story, but most economists cannot find hard evidence that lower taxes on financial income lead to significantly higher overall investment. And even if there were such evidence, the link between productivity gains and broad wage increases broke down in the last decade, which is another reason why income and wealth inequalities have reached record levels.

We can see the role of tax policies by comparing what has happened to the incomes of different groups, before and after taxes. To begin, from 1979 to 2007, after-tax income grew faster than pre-tax income up and down the income distribution. Tax policy, then, reduced tax burdens across the board. At the bottom, however, the effect has been distinctly progressive. The average, inflation-adjusted, pretax income of the lowest 20 percent of Americans declined by 7 percent from 1979 to 2007. But the same groups average, real post-tax income increased by 14 percent. Similarly, the average real income of those in the second income quintile fell by 4 percent before taxes, and rose by 23 percent after-tax over the same years. In short, tax cuts more than offset falling wages at and near the bottom, especially the expansions of the Earned Income Tax Credit, the deduction for children and the standard deduction.

The heart of the middle class, the third income quintile, saw their average income grow 11 percent before taxes and 23 percent after taxes over the same years. That means that about half of their modest economic gains came from the economy and half from tax policy. Similarly, for Americans in the fourth income quintile the top 60 percent to 80 percent by income average income grew 23 percent before taxes and 36 percent after taxes. The economy delivered faster income gains to this group than to those in the middle, and then Uncle Sam added half again as much through tax policy.

From this point until the very top, the gains from tax policy increase with income. Across the top 20 percent, average income from 1979 to 2007 rose 49 percent before taxes and 96 percent after taxes, or roughly half from economic effort and half from tax policy changes. The result: pretax gains grew twice as fast as those in the next lower income quintile, and post-tax gains which grew three times faster. Similarly, for the top 5 percent of Americans, average incomes increased 73 percent before taxes and 160 percent after taxes a split of 45 percent from the economy and 55 percent from the tax writers. And their pretax incomes grew 6.5 times faster than those in the middle, while their post-tax incomes grew 7 times faster.

For the lucky few in the top 1 percent, most of the gains did come before taxes: From 1979 to 2007, the average income in this rarefied group increased 241 percent before taxes and 281 percent after taxes. So, the pretax incomes of the richest Americans grew 22 times faster than the incomes of middle-class Americans, while their post-tax incomes grew only 12 times faster and yet Washington still gave them an additional 15 percent through new tax breaks.

Over the last 30 years, then, U.S. tax policy has sustained at least two large themes. As the income gains of many Americans slowed down, Washington has consistently used tax cuts to blunt some of the inevitable public disappointment and resentment. And second, those tax changes have ultimately reinforced an historic increase in economic inequality, creating a treacherous new political environment for wealthy office-seekers who pay little taxes.

The Economics and Politics of Contemporary Inequality, Part 1

February 7, 2012

Barring some unforeseeable event, Mitt Romney is virtually certain to be the GOP nominee for president. Judging by President Obamas decision to make inequality a main theme of his State of the Union address, the White House has been counting on facing Romney. More than anyone else in national politics, Mitt Romneys own deeds and words may be said to embody the dynamics which define the top end of contemporary inequality. He spent his adult life accumulating capital assets, he deployed those assets to earn higher returns than those available to middle-class people, and he took aggressive advantage of the highly favorable tax treatment accorded those assets.

Even so, why have wealth and economic inequality become powerful political issues today, when the fortunes of John Kennedy, both George Bushes, John Kerry, and even the billionaire Ross Perot did not? The big difference, of course, is timing. For one, the rich have become much richer, both absolutely and relatively. In 2007, the top 1 percent took home 23.5 percent of all of the income earned in the United States. Thats the same share the top 1 percent claimed in 1928. But for the next half-century, the income share of the top 1 percent fell slowly but steadily, reaching less than 9 percent of national income in 1976. Throughout those years, the incomes of everyone else grew faster than the incomes of those at the top, creating a vast American middle class. But since 1976, incomes at the top have once again grown faster than everyone elses incomes, restoring their pre-Depression share.

That still doesnt explain why the very rich in politics inspire so much more wariness and anger today than just 12 years ago, when George W. Bushs wealth didnt faze most Americans and unlike Romney, he didnt even earn it. After all, one standard liberal meme cites the data on median incomes in 1976 and 2010 to insist that most Americans have stagnated economically for 35 years. Behind those two data points, however, lies a more complicated reality which shows that most Americans did make real economic progress until the last decade.

First of all, everybody ages; and as we do, most of us see our incomes move from somewhere below the median to somewhere above it. Moreover, real median incomes did increase at respectable rates throughout the expansions of both the 1980s and 1990s, although the recessions which followed took back some of those gains. From 1983 to 1989, real median income increased more than 2 percent per-year, before giving back nearly half of those gains in the 19901991 recession and its aftermath. It happened again from 1993 to 1999, when median income rose by nearly 2.5 percent per-year, and then gave back 30 percent of those gains in the 2001 recession and the following three years.

The reason Americans seem so much more skeptical of the very wealthy today, is that this pattern has broken down. Not only did median income fall for three more years after the 2001 recession, that was followed by annual gains of barely 1 percent from 2004 through 2007. Moreover, the 20082009 recession and the year following it took back all of those gains, twice over. The result is that by 2010, median income was back to levels last seen in 1996 and 1989.

Also, while the recessions of the 1980s and 1990s drove down median income, those losses were fairly concentrated near the bottom and at the top. The people most likely to lose their jobs in recessions are those in the second and third income quintile, and their incomes fall fairly sharply. At the top, most income comes from financial assets. And since recessions drive down both stock markets and interest rates, they cut sharply into and the capital gains, dividends and interest that especially enrich the top 1 percent. So, for example, the 19901991 recession and the initially slow recovery that followed cost an average household in the second income quintile more than 2 percent of their annual incomes. Moreover, the average household in top 1 percent saw their annual capital income fall by nearly 20 percent. In between, most Americans kept their jobs and held on to most of their incomes gains from the 1980s and 1990s.

So, from 1983 to 2000, the average income of the first three income quintiles covering the less affluent 60 percent of Americans grew steadily by an average of 1.3 percent per-year. People in the fourth income quintile the equivalent of a $90,000 income today did better. They registered average income gains of nearly 1.7 percent per-year from 1983 to 2000. Households in top-earning quintile did better still, with annual income gains of more than 4 percent from 1983 to 2000. And consistent with the top 1 percents outsized share of total income, those households way outpaced everyone else: Their incomes grew by nearly 10 percent per year from 1983 to 2000.

After 2000, most peoples gains first turned to losses, then grew slowly for a few years, and then fell back sharply in the 20072009 recession. But once again, the story is different for those at the top. To be sure, the incomes of the top 1 percent fell by nearly 30 percent from 2000 to 2002, along with stock and bond markets. From 2003 to 2006, however, those markets recovered, and the incomes of the top 1 percent increased 65 percent. More recent income data for the very wealthy are not yet publicly available. But while everyone else struggles to regain their financial footing, the top 1 percent has seen the S&P 500 and other market indexes already recover. And if all of this wasnt enough to make Americans pause before making one of the countrys richest men the president, federal tax changes pressed by presidents over the same period have exacerbated the inequalities. That will be our topic for next weeks blog.

John Kennedy famously reminded us that life can be unfair. JFKs focus, unsurprisingly, was on matters of greater import than wealth: To illustrate that [t]here is always inequality in life, he notes, [s]ome men are killed in a war, and some men are wounded, and some men never leave the country. Life is unfair. Mitt Romney has had a lions share of extraordinarily good luck in his life. Now, he will have to make his run for president at a time perhaps the first such time in generations when millions of Americans will be very wary of a candidate who grew rich while everyone else struggled just to hold on.